Chapter 8

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  • 1. CHAPTER 8
    VALUING & FINANCING AN INTERNET START-UP
    Explore cash flow, price-earning ratio (P/E), price-earning growth (PEG),& business model based methods in valuing start-up/new company.
    Financing strategies, different source of financing
    “You need money to make money”
  • 2. WHEN TO CASH OUT (WITHDRAW MONEY)
    DURING FIRM’S LIFE CYCLE : revenue received during business period, can use cash inflow to cover any expenses or cash outflow
    COLLECTING EARLY: selling equity to gain early profits, the buyer gets a piece of the company usually venture capital, individual investor (rich people), or go through INTIAL PUBLIC OFFERIC (IPO)list your company to MESDAQ the Bursa Saham Malaysia , anyone can buy share & you make money
    Investment bank that has lots of money & interested in your company
  • 3. E.G. IPO
    RICH-RICH COMPANY
    SDN BHD
    (SOFTWARE DEVELOPER)
    • Paid up capital RM 50,000
    • 4. Revenue year 1 RM 40,000
    • 5. Received Government
    Contract 5 years ,RM 5million
    • Needs capital, What to do?
    RICH-RICH COMPANY
    BHD
    (SOFTWARE DEVELOPER)
    OR
    IPO
    BANK LOAN
    • Get big fast
    • 6. Fast growth
    • 7. Equity shared by people
    • 8. Public know what's your
    worth
    • Long term liability
    • 9. Slow growth
    • 10. Can keep own company
  • VALUATION OF A BUSINESS
    CASH FLOW
    PRICE-EARNING (P/E)
    PRICE-EARNINGS GROWTH (PEG)
  • 11. 1. CASH FLOW
    Value of a stock, bond or business is determine by the cash inflows & outflows
    Advantage of internet companies over traditional business is that Internet properties used & improved cash flow
    Amazon. COM +ve cash flow, holds no inventory thus, –ve operating expenses
    FREE CASH FLOW-cash from business operation available for distribution to its claim holder, equity investors & debtors-that provide capital.
  • 12. 2. PRICE-EARNING (P/E) RATIO
    Reflects investor’s expectation of future earnings
    Compare with same industry
    Example pg 147.
    I’m rich. COM
    2001
    Year 2002 earnings $3million
    Year 2003 process of going public
    -suggest that issue $5 million shares during IPO
    Other P/E ratio of same industry firm are 80.
    What should your share price be?
    P
    $0.6
    P
    E
    80
    $48
    =
    =
    =>
    P
    =
  • 13. Shortcoming of P/E ratio
    Firm can be profitable but have –ve free cash flow
    There are more than 1 type of earnings, to decide which one to use is not easy
    Because you are comparing, therefore whether historical earnings are a good predictor of future earnings are questionable.
  • 14. 3. PRICE-EARNINGS GROWTH (PEG) RATIO
    Analyze the role of growth
    Same formula as P/E ration with adjustment to growth
    P/E
    Growth Rate
    Stock with PEG ratio less than 1.00 are good buys
    Has limitations/shortcomings
    Valuable information lost
    =
  • 15. VALUATION OF BUSINESS THAT ARE NOT YET PROFITABLE
    How do you estimate the value of a firm that has –ve earnings?
    Use this method:
    Firm & industry Proxies
    Business Model Approach: Earnings & cash Flow Chain
    Implications of Market Value for Financing & Investment Strategies
  • 16. 1. Firm & Business Proxies
    A firm’s share price is estimated using the P/E ratios of analogs
    Analyzing a firm based on its industry growth, target market & leader in its category
  • 17. 2. Business Model Approach: Earnings & cash Flow Chain
    Turn a firm’s business model for some indications of future earnings potential
    Technology & internet firm tend to loose money in their early years of operation & gradually gain market & money along the way
    Its indicator of future profitability are profit margin, market share, revenue growth.
    Figure 8.2 method used in estimating share price
  • 18. 3. Implications of Market Value for Financing & Investment Strategies
    How can one tell is a firm is over valued?
    Compare P/E ratio of current firm to historical P/E ratios of firm in same industry
    Check pg 150 example.
  • 19. INTELLECTUAL CAPITAL: VALUING THE PARTS
    Intellectual capital:
    Unpriced physical assets /intangible assets, patent trade secrets
    Human capital-people that turn assets into products & services
    Product market position
    Unique resource or capabilities
    knowledge
  • 20. Components of Intellectual capital
    Intellectual property
    Human capital-workers
    Organizational capital-customer value & cultivate more intellectual property
  • 21. FINANCING A START-UP
    Internal Sources: Assets & Activity
    Equity
    Debt
    Complementary Assets
  • 22. 1. Internal Sources: Assets & Activity
    Firm can use retained earnings
    Retained earnings = profit that firm makes, net any dividends that paid to shareholders
    Firm can use existing assets for innovation
    Hewlett Packard & Apple starts in garages in Silicon Valley
  • 23. 2. Equity
    Firm can also issue equity thro’ equity financing-giving equity as share to investors, in return giving the firm capital/management
    Issued through IPO-popular in 1990’s
    Venture equity -VC/Venture Capital comes in & finance firm in early stage of company formation by asking for share in the company & sits on its board & gives management advice-seek cash after company becomes IPO, e.g. NETSCAPE,AMAZON.COM e.c.t.
    Drawbacks of this method- the VC had control over you- usually 51% of the company
  • 24. 3. Debt
    Borrow money to finance your company
    Needs collateral- something to put in before money can be given-banks, financial institution, along
    Interest payment, major setbacks for star-up companies.
    Working capital financing- used by AMAZON.COM-smart form of debt financing
    Malaysian banks.
  • 25. 4. Complementary Assets
    Paired assets by strategic alliances with partners
    team up with other firm that has assets